Is Japan’s ‘lost decade’ a window to the future?
It hit suddenly, and when the bubble burst it was a wipeout. As today’s crisis deepens, the unthinkable is becoming all too real
November 22, 2008
TOKYO — As the worst financial crisis since the Great Depression unfolds around the world, everyone is wondering what the future holds. How bad could this get? For some sobering answers, just ask Kazumi Suzuki.
With a bitter laugh, he recalls how he survived the worst days of Japan’s economic crisis, left his job as a banker when head office closed his branch, and went into business selling organic vegetables. He was certain it was a sure thing as Japan recovered from its hard times and an aging, health-conscious population started spending again.
Now, the world’s second-biggest economy is in trouble once more and consumers are looking on his vegetables as an unaffordable luxury. Mr. Suzuki and his staff of 10 are hanging on by their fingernails.
“If you had asked me a year ago, I would have said we’ve hit the bottom and we’re looking forward to a gradual recovery, but now everything is grey-looking,” he said over lunch at his health-food café in Osaka. “We are in a long tunnel and we cannot see any sign of light.”
Kato Takumu can’t see it either. He had to leave his job as a high-school science teacher four years ago for medical reasons. He hasn’t been able to find full-time work since. Instead, he works in a convenience store in suburban Tokyo, pulling the night shift two times a week, unloading boxes, manning the cash and scrubbing out the roast-chicken pans for $15 an hour. At 44, he lives with his aged parents, subsisting on his father’s pension. “We all thought we belonged to the middle class,” he says. But in a country that values equality, “the gap between haves and have-nots is growing.”
Japan’s painful hangover from its own version of the global financial crisis is a grim lesson for those who hope for a quick recovery from the present one. Japan is the only major industrialized country since the Great Crash of 1929 to go through a crisis of a similar scale. Like the United States and other world economies today, it suffered a market meltdown, a collapse in consumer confidence and a crisis in its banking system.
It has never fully recovered. After being knocked flat on its back by the bursting of a stock-market and real-estate bubble in the early 1990s, it stayed there for the rest of what became known as its “lost decade.” It bounced back slightly after the turn of the century, only to head into trouble again as the global economy weakened. In all, the aftereffects of its crisis have lasted nearly two decades.
Is it possible that North America and other parts of the world could suffer as long? Just a few months ago, the idea seemed far-fetched. But as the crisis widens and deepens, it no longer seems so implausible. Some argue that Japan was actually in better shape after its bubble burst than the United States and other hard-hit countries are today. Yet Japan suffered four recessions after the bubble burst in 1990 and has just entered a fifth.
If Japan is any guide, it will take much more time to rebound from the current global crisis than many of us expect. Much more money, too. Of all the lessons from Japan’s unhappy experience, the most profound may be: Expect the worst. This is going to be a long, rocky ride.
“I think people are being naive about the severity of the adjustment and, more importantly, the length of the adjustment,” said Jesper Koll, an analyst for Tantallon Research Japan who lived through the lost decade. “I’m not a scaremonger, but it’s time to be realistic.”
Japan’s crisis seemed to hit like a lightning bolt from a clear blue sky. In the late 1980s, Japan was on top of the world. Its “miracle economy” had grown by an average of 10 per cent in the 1960s, 5 per cent in the 1970s and 4 per cent in the 1980s, putting its Western rivals to shame. Companies such as Honda, Canon and Sony were flooding the globe with Japanese-made cars, cameras and television sets. Japanese companies bought prized overseas assets like New York’s Rockefeller Center and California’s Pebble Beach golf course. In books such as Ezra Vogel’s Japan as Number One, analysts predicted that Japan’s tight-knit social fabric, disciplined business culture, hard-work habit and government-directed growth strategy gave it an irreversible edge over the tired economies of the West.
But trouble was brewing. Officials deregulated the financial markets and lowered interest rates, the same combination that would lead to the credit fiasco in the United States. With money easy to borrow, companies invested heavily in property and stocks, sending prices soaring. The Nikkei stock-market index more than tripled from 1985 to 1989. A square foot of land in Tokyo’s Ginza shopping district was going for $139,000 (U.S.). It was said that the property around the sprawling Imperial Palace was worth more than the whole state of California.
When the bubble finally burst, it was a wipeout. The Nikkei dropped by two-thirds over the next two years. Commercial land values in the big cities fell by 80 per cent between 1991 and 2000. They never returned to their bubble levels. Neither did stocks. Today, the Nikkei stands at one-fifth of its 1989 peak. If the Toronto stock exchange were to perform as badly, the index would stand at 3,000 in 2027, compared with about 8,000 today.
As stock and land values fell, companies that had borrowed to buy them found that they could not repay their banks. By 1997, the banking sector was in crisis, and the government had to rush in to bail it out by injecting funds into the system. Meanwhile, the economy languished. Between 1990 and 2005, real growth averaged just 1.3 per cent a year, a national embarrassment in a period when the United States was enjoying its longest postwar boom and China’s pell-mell growth was the wonder of the world. The unemployment level nearly tripled, from 2 per cent to about 5.5 per cent.
Columbia University scholar Bruce Greenwald has estimated the cost to Japan of the lost growth at $50-trillion (U.S.) in today’s dollars. Another analyst, Richard Koo of Tokyo’s Nomura Research Institute, says the fall in land and stock values wiped out the equivalent of three years of Japanese national output, or gross domestic product, “the greatest loss ever experienced by a nation in peacetime.” During the Great Depression, by comparison, the United States lost the equivalent of one year of GDP, he says.
These were more than just paper losses. Ordinary people suffered, too. The Japanese government managed to avoid mass misery by spending hundreds of billions of dollars on public works and slashing interest rates to the bone (they have been at zero for almost six years). But homeless encampments grew in city parks. Suicides soared. The system of lifetime employment that had guaranteed workers at big companies a secure living from graduation to retirement began to crumble. The proportion of workers with part-time or contract status grew from 21 per cent to 41 per cent.
If things did not get even worse, it was partly because governments were transferring the cost of maintaining the Japanese standard of living to future generations. Because of all that pump-priming government spending, governments have run budget deficits year after year for almost two decades. Total public debt has grown to 180 per cent of gross domestic product, the highest for any industrialized country. Someone is going to have to pay that down one day through higher taxes.
An even higher cost may have been exacted on the psyche of the Japanese people. They are still traumatized by lost-decade experience. Consumer confidence, the fuel of any modern economy, has never really recovered from the 1990s. In fact, it has just hit its lowest level since 1982. Instead of spending, Japanese stuff whatever extra money into bank accounts that, thanks to zero-per-cent interest rates, earn them next to nothing. That makes it hard to save for retirement and the Japanese work force is aging faster than in any other major country.
“The scars of the bubble era run so deep,” says Graham Davis, Japan director of the corporate network of the Economist Intelligence Unit. “It’s almost like remembering the Depression era in the U.S.”
Japan even experienced a bout of that most dangerous of economic diseases, deflation. Excess capacity and falling demand caused prices to drop and consumers to put off purchases in anticipation of further drops, almost sending the economy from stagnation to Depression-style tailspin. Home prices remain 40 per cent below their bubble-era peak, a fact that is obviously deeply discouraging to millions of homeowners.
So this is Japan in 2008: asset values still depressed, public debt still rising, consumers and investors still scared out of their wits – all nearly 20 years since the trouble started. Will the rest of the world have it so bad? Will we still be dealing with the collapse when babies born on the day that Lehman Brothers went bankrupt enter university?
Most analysts think not. The consensus seems to be that because the United States is moving faster to deal with its problems, it will avoid the long, dark tunnel that Japan went through. In a recent report, economist Richard Jerram of Macquarie Research in Tokyo says that “the speed and aggression of the U.S. response gives hope that it will avoid following the path of Japan in the 1990s.”
But is Washington really moving so much faster? That may be something of a myth.
It’s true that Japan was slow off the mark in the 1990s, particularly at dealing with troubled banks, which hid their losses and bad loans for years out of fear they would go bust if caught out. It wasn’t until 1994, four years after the start of the crisis, that taxpayers had to bail out their first financial firms: two Tokyo credit co-operatives. It was another three years before bigger banks and securities companies started to fail.
Along the way, Japan made some colossal mistakes. It raised the consumption tax in 1997, derailing consumer confidence, and it raised interest rates in 2000 when the Bank of Japan thought deflation was licked.
A report by the U.S. Congressional Research Service says that Japan lacked “political leadership that would have urged authorities to take action earlier.” With a fresh, new administration under Barack Obama that considers the financial crisis its most urgent priority, Washington does not lack for leadership.
Still, Japan moved fairly quickly to cut interest rates when real-estate values started to plummet in 1991. At the same time, it started to run bigger budget deficits to stimulate the economy, pulling it at least temporarily out of its post-bubble recession of 1993-94.
A second myth is that Japan suffered more than the United States and other countries will today because its bubble was so much bigger. In reality, the credit and asset bubble that built up in the United States was the biggest in history. At the peak of Japan’s bubble, it needed three yen of credit to make one yen of national income. The United States needed eight dollars of credit for every dollar of income. In Japan, the bubble grew for only about five years in the high-flying late 1980s. In the United States, the credit binge has been going on for a couple of decades.
It was aggravated by the process of bundling mortgages into complex securities that could be sold to investors. Japan did not indulge in this “securitization.” Nor did Japanese borrow massively against their homes to finance their spending. Big lines of credit or second and third mortgages were virtually unheard of in Japan. In the United States, the total debt held by the mortgage companies Freddie Mac and Fannie Mae rose tenfold to $1.5-trillion from 1990 to the end of 2007. “Everything considered, Japan’s bubble pales in comparison,” writes Tokyo banking analyst Kristine Li in a recent research report.
So, in some ways at least, the United States may not in fact be in better shape than Japan was during its crisis. To the contrary, Japan had some advantages that the United States lacks.
For one, it was (and still is) a creditor nation, with more money flowing in than out. Its current account, a measure of all transactions in goods, services and interest payments, has a surplus of $1.3-billion a day, while the United States has a deficit of $2-billion. That is important because a deficit nation such as the United States will find it harder to finance the rising debts that it will incur to dig itself out of the current mess.
To make matters worse, Americans entered their crisis with a savings rate of zero. In Japan, it was 16 to 17 per cent. Japanese could cope by reducing that over time to about 2 per cent. What will Americans do?
“To put it bluntly, America is much worse off, because there is no buffer,” said Mr. Koll of Tantallon Research. “America runs without a safety net.”
It also lacks outside help. When Japan was going through its crisis, it could count on demand for its products from booming China and North America to ease its pain a little. Things are different today. With just about every major economy in trouble, North America has no one to pull it out of the mire.
One other thing makes the U.S.-based crisis potentially worse than Japan’s. In Japan, it was companies that got themselves into debt in the boom years, and then had to go through the painful process of “de-leveraging,” or paying off their loans. In the United States, the problem lies more with households that borrowed too much, then saw the values of their homes plunge.
Akira Kojima, a senior fellow at the Japan Centre for Economic Research, points out that the average U.S. household has a debt equivalent to 160 per cent of its income when credit card debts are factored in. Getting out from under that burden will take years.
“Companies can de-leverage,” said Mr. Kojima. “They can fire people, they can cut salaries, they can sell assets. But with households, it’s harder.”
None of this means that the rest of the world is doomed to suffer Japan’s dismal fate. Although economists still debate what Japan should and should not have done, most agree that it did not wake up soon enough to the depth of its troubles. Japanese policy makers thought the stock and real estate downturn of the early 1990s was simply another phase in the usual up-and-down business cycle, not the beginning of a prolonged crisis involving the whole corporate world and banking system.
But, then, policy makers on this side of the Pacific made the same mistake. Just 10 months ago, USA Today wrote that “most economists expect a brief recession that will give way to renewed, if anemic, growth in the second half of this year. Few expect to see Japan’s ‘lost decade’ replayed here.” Can we still be so sure?
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